The Non-Income Determinants of Consumption and Saving

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					The Non-Income Determinants
 of Consumption and Saving
  Plus: An Introduction to Investment
   and the Interest Rate Relationship
The Non-DI Determinants of
 Consumption and Savings

Wealth        Expectations

• The value of real assets (houses, land) and
  financial assets (cash, stocks, bonds).
• When wealth increases, households increase
  spending and reduce savings.
• This is called the wealth effect, and it shifts
  the savings schedule down, and consumption
• The opposite occurs when wealth decreases.
• About future prices and income.
• Expectations of rising prices in the future will
  cause an increase in consumption and
  decrease in saving.
• This shifts the consumption schedule upward
  and savings downward.
• The opposite occurs when there are
  expectations of a recession or lower income.
• Taxes are paid at the expense of consumption
  and savings.
• If taxes increase, we save and consume less.
• Conversely, tax reductions by the government
  encourage us to buy and save more.

• Thinking & Inquiry: Why might the
  government be afraid to raise taxes to pay off
  the debt during a slow economy?
            Household Debt
• Increased borrowing increases current
  consumption. This moves the consumption
  schedule up.
• Decreased borrowing reduces consumption.

• Thinking & Inquiry: Why at high levels does
  increasing levels of debt cause serious
  problems for future savings and consumption?
Curve Analysis: “Movement” versus “Shift.”
   Making Investment Decisions:
     The Main Determinants

 Expected       •Expressed as
  Rate of
  Return         (r)

Interest Rate   •Expressed as
on Borrowed
   Money         (i)
       Expected Rate of Return
• Businesses only make investments when they
   expect them to be profitable.
  r = (Expected Revenue - cost of investment) /
               cost of investment.
• Firms are risk takers, and returns are not
The Real Interest Rate and Analysis
• Businesses only invest when the rate of return
  is greater than the interest rate (r > i)
• You take out a loan for $1000 to buy a
  machine. If the interest rate is 7%, you pay
  $70 in interest.
• If the rate of return is 10%, then you generate
  $100 extra from the machine.
• Your net profit is $30 ($100-$70)
             Test Preparation
• In groups of four, read 191-193.
• Try to explain what you read to each other in
  simple and clear language.
• Discuss and complete the following potential
  test questions: # 4 and # 6 on pg. 223.

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